A with-profit endowment policy is a contract written by a life assurance company to pay a fixed sum (called the basic sum assured) plus accumulated profits (that are declared annually), to an assured person on a fixed date in the future (or to his/her estate if the person dies prematurely), provided that the premiums have been paid as required by the contract.

There are two types of with-profit endowment. The first is called a full with-profit endowment. This is the most expensive type and guarantees to pay at least the value of your loan on maturity. A more common product is a low cost with-profit endowment, which also has a guaranteed maturity value, but with this type of policy, the guaranteed maturity value starts as only a fraction of the loan amount and there is no certainty that it will end up be enough to repay your loan.

With both types, the accumulated profits are added to the fund by way of bonuses awarded each year. The size of these bonuses depends on the performance of the investment fund - in effect, the owners of the policies are participating in the profits of the life company. Once added, these bonuses cannot be taken away. There are three types of bonuses:-

Reversionary bonuses

These bonuses are declared annually as cash values computed as percentages of the basic sum assured and of bonuses declared in previous years. Once granted, these bonuses are guaranteed, cannot be withdrawn and are also known as attaching bonuses.

Special bonuses

These are one-off bonuses, granted at the discretion of the life company and are also guaranteed. For example, if a friendly society converts to a public company they may grant such special bonuses to each policy in force, instead of issuing free shares in the new company.

Terminal bonuses

Most life companies currently grant an additional bonus at the end of the life of a policy. In essence this is a loyalty bonus designed to encourage the policy holders to keep the policies in force until the maturity date. The size of the terminal bonus is dependent upon the investment conditions prevailing at the time of maturity, as well as upon the investment performance of the life company. Although it can be a large part of the final sum paid out, it is not guaranteed.

There is also a final bonus that depends partly on the performance of the fund over the entire term. The terminal bonus may represent a large portion of payout and is guaranteed to be at least enough to repay the soan.

• There is a possibility that the bonuses will take the maturity value above the level required to pay back the loan. This would result in a tax-free cash surplus, which you can spend on whatever tickles your fancy.
• The maturity value grows throughout the life of the policy. The size of the final or terminal bonus makes it rare to be able to cash in this type of endowment policy early without losing out. You may end up getting back less than you put in.